central bank

central bank,

financial institution designed to regulate and control the money supply of a nation, with the goal of fostering economic growth without inflation. Although central banking systems have varying levels of autonomy, there is generally a significant level of government control. The responsibilities of the central bank usually include maintaining adequate reserve backing for the nation's commercial banks and regulating the exchange rate of the nation's currency. Such duties are met by controlling the discount rate, making reserve advances to commercial banks, trading in government obligations, and acting as the government's fiduciary agent in its dealings with other governments and other central banks. The central bank has been called the "lender of last resort" and is expected to lend to its nation's banks at any time, particularly during a panic. Although the term was hardly known before 1900, the concept of central banking dates back to at least 1694, when the Bank of England was founded. Today, all economically developed nations—and most developing nations—possess the equivalent of a central bank; there are 172 central banks around the world. Notable central banks include France's Banque de France, Germany's Bundesbank, and the U.S. Federal Reserve System (est. 1913). The Bank for International Settlements in Switzerland serves as a central bank for the central banks of the world's largest capitalist nations. The World Bank and the International Monetary Fund also serve certain central banking functions for member nations. The European Union established the European Central Bank in 1998 as a prelude to the adoption of the euro (see European Monetary System). In the United States, the inflation crisis of the late 1970s led to greater public awareness of the role of the Federal Reserve in setting interest rates; reaction to its decisions (and expected decisions) concerning interest rates often produces sharp movements in the stock and bond markets.

Central Bank

 

in capitalist countries, an institution for the state-monopoly regulation of the economy which has a monopoly of bank note issue and which organizes and controls the circulation of money and the availability and cost of credit in the country.

In the early stages of capitalism, banks engaging in commercial activities (accepting deposits and granting loans) also issued bank notes. In the period between the mid-19th and early 20th centuries, the right to issue bank notes in most of the developed capitalist countries was granted to only certain banks. Thus, the Bank of France has been the country’s sole bank of issue since 1848; in the United States, the Federal Reserve System (comprising 12 regional banks) was set up as the country’s central bank in 1913; in Russia, the State Bank, founded in 1860, was the central bank. In Great Britain, the issuance of bank notes was at first not the exclusive preserve of the Bank of England. However, the aggregate issue of bank notes by other banks was negligible. (In 1844, there were £19 million in circulation in the form of bank notes issued by the Bank of England and approximately £8 million worth of notes issued by other banks; at the beginning of the 20th century, the respective figures were £30 million and £1 million.) Since 1921 the Bank of England has been the country’s chief bank of issue.

The role of the central bank as an instrument of state economic policy has grown enormously in the age of state-monopoly capitalism. After World War II, the developing countries created their own central banks with the aim of issuing national currencies to replace those that had been in circulation under colonial regimes and using bank credit to promote economic development.

Central banks issue bank notes and control the money supply. Government paper accounts for the bulk of the currency in circulation today in capitalist countries. Since the paper is not backed by gold, public confidence is of the utmost importance. As of the mid-1970’s, only in a few countries was gold used to back bank notes domestically (Switzerland, 40 percent; Belgium, 33 percent; Portugal, 25 percent) or internationally (Netherlands, 50 percent; Denmark, 25 percent).

Central banks also keep the banking reserves of commercial banks and grant credit to these banks (serving as a “bankers’ bank”). While in some countries (Finland, France, Switzerland, Japan) the central banks are authorized to conduct business with clients other than banks, the volume of these transactions is negligible. In addition, the banks control the country’s monetary reserves and perform fiscal services for the government. With the chronic budget deficits of capitalist countries, credit granted by central banks to the state in the form of investments in government paper significantly exceeds the value of the budgetary funds on deposit in the banks.

Central banks influence the volume of credit and the level of business activity of commercial banks through monetary and fiscal policies, through changes in the rate for rediscounting commercial paper for commercial banks (thereby raising or lowering the cost of bank credit), and through changes in the limits imposed on the rediscounting of commercial paper in central banks. Credit and business activity is also affected by the buying and selling of government securities “on the open market” by central banks.

Central banks have a direct control over commercial banks by virtue of the standards that they set and enforce (minimum cash reserves, minimum liquidity ratios, rules governing bank mergers). After a wave of bankruptcies by banks in 1974, a number of countries tightened this control to the point where commercial banks are required to submit regular reports to the central banks.

In addition to organizing, with the aid of special clearinghouses, transactions that do not involve actual money or credit transfers, central banks serve as the repository for reserves used to make international payments, support the exchange rate of the national currency, and exercise currency control functions. They also collect and publish financial and economic statistics and advise government bodies and banks on currency and financial matters.

E. D. ZOLOTARENKO